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Detroit sues over pension debt deal that quickened bankruptcy

Detroit Emergency Manager Kevyn Orr announced Friday that the city is suing several retiree corporations over a messy financial transaction that contributed to Detroit declaring bankruptcy last July.

The $1.4 billion pension debt deal was negotiated in 2005 and 2006 by then-Mayor Kwame Kilpatrick and lauded as a way to keep Detroit's pensions funded and prevent layoffs.

However, it has cost the city $202 million since 2009, according to Orr's office, as the interest rates on which the deals were based plunged.

"This deal was bad for the city from its onset despite reassurances it would adequately resolve the city's pension issues," Orr said in an emailed statement. "We have tried, without success, to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions."

Two weeks ago, Judge Steven Rhodes of U.S. Bankruptcy Court denied a mediated settlement that the city had worked out with UBS AG and Bank of America Corp. to pay about $165 million to settle the contracts.

That was the second time the city and creditors had proposed such a plan to Rhodes, but he still said the deal was too sweet for the banks. They had agreed to accept $165 million to end the deal, down from the original $230 million settlement.

"The court will not let the city continue hasty decisions," Rhodes said. It's not in the best interest of Detroit to "enter into bad deals" to solve its financial problems, he said.

That left Orr the nuclear option — which was suing on the grounds that the original deal was illegal under Michigan law.

"Our position is that in lieu of reaching a settlement, these are illegal transactions to begin with, said Bill Nowling, Orr's spokesman. "So we are asking a judge to invalidate them because the city did not have the authority to create these straw organizations to offer these notes."

In his earlier ruling, Rhodes said the city would have a fair chance of winning that argument.

However, Orr has said he didn't want to sue because it could tie up the bankruptcy for years and delay reinvestment in city services.

The city is suing the Detroit Police and Fire Retirement System Service Corp., the Detroit General Retirement System Service Corp., the Detroit Retirement System Funding Trust 2005 and the Detroit Retirement System Funding Trust 2006.

These corporations have no connection to the pension systems. These were corporations created by the city and the underwriters just to issue the original pension obligation certificates (COPs).

Orr is suing these retirement corporations, rather than the banks, because he argues that their formation was fraudulent and that therefore, the entire deal was illegal.

He is continuing to negotiate with the banks, Nowling said, in an attempt to find a settlement deal that could wrap the issue up more quickly. And — more important to residents — give the city access to $15 million a month in casino revenue to reinvest into things such as streetlights and other city services.

Under the original deal, the city used its casino revenue as collateral. So if the city defaults on the loan, that income stream could be trapped. It's a little like using your direct-deposited paycheck as collateral on a loan. If you default, then the lender gets to keep your main source of income.

"It's very messy," Nowling said. "We still have to pursue (the banks) because that's actually where the casino revenue is tied up. This is always about getting access to the casino revenue. We want those revenues for what's coming ahead, the reinvestment."

Orr is expected to file his final plan of adjustment — essentially the laundry list of how he expects to get out of the financial mess and how much of a hit different creditors will take — by Feb. 14. In that plan, Nowling said, will be either a deal or lawsuits against the banks.

"If we don't come up with an agreement in the next day or so, we'll have to come up with a decision on the legal action to keep the casino revenue from being trapped."

Originally, Orr intended to pay off the banks and fund his reinvestment plan through a $285 million loan from Barclays PLC. But when Rhodes rejected the city's deal with the banks, it spun that loan into uncertainty, too. Although Rhodes approved $120 million of the proposed loan, the question remained whether Barclays would want to move forward with a much-altered deal.

Legal experts have questioned the likelihood of the loan.

Barclays "will need to know that there is a funding source for repayment and that they will be comfortable with it," said Douglas Bernstein, managing partner of the banking, bankruptcy and creditor's rights practice group at Plunkett Cooney PC in Bloomfield Hills. "If their approval contemplated the gaming revenues as a component and they are no longer available, then it would appear to be a different deal that needs further negotiation."

Nowling said that city officials are still talks with Barclay's but that some significant hurdles remain.